Does Your Client Want to Divest From Fossil Fuels?

Many clients don't like companies that pollute. Dan Kern and HIP Investor lay out the realities of constructing a fossil-free portfolio.

By Joyce Hanson|September 23, 2013 at 01:39 PM

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Hodges Capital Management founder Don Hodges may know his way around a balance sheet and a price-to-earnings ratio, but when it comes to investing in tobacco or alcohol manufacturers for any of his five mutual funds, Hodges just won’t do it no matter how good the numbers look.

Why not? “My mother wouldn’t like it,” says the man who began his investment career in 1960 with Merrill Lynch, recalling that his mom and dad disapproved of drinking and smoking when he grew up in small-town Texas.

Similarly, Hodges notes, Hodges Capital today gets requests from clients, women especially, to avoid any investments in environmentally irresponsible companies. “More and more,” he says, “We have people coming to us saying we don’t want you to invest in this or that company because they’re polluting and bad for the environment.”

Across the U.S., as Hodges’ experience attests, investors are putting pressure on firms to consider environmental, social and governance (ESG) factors when making business decisions. This is especially true of fossil fuels, suspected to cause climate change. The writer and environmental advocate Bill McKibben and his organization, 350.org, have spurred activists on more than 300 college campuses to demand that their schools divest the top 200 oil, gas and coal companies from their endowments.

Do Your Homework

As a result of the growing interest in this issue, wherever financial advisors and wealth managers might personally stand on the debate, many will field requests from clients about divesting from energy companies with exposure to fossil fuels. And for those advisors who are fiduciaries, doing some homework on this sticky subject might be a good idea before the next pro-divestment request comes in from a foundation, university or socially responsible individual investor.

A recent speech on climate change by President Barack Obama at Georgetown University suggests just how top-of-mind the subject of divestment has become, not just on college campuses but in communities nationwide.

“Convince those in power to reduce our carbon pollution. Push your own communities to adopt smarter practices. Invest. Divest,” Obama said in his June 25 speech to a large audience. “Remind folks there’s no contradiction between a sound environment and strong economic growth. And remind everyone who represents you at every level of government that sheltering future generations against the ravages of climate change is a prerequisite for your vote.”

Dan Kern, a chartered financial analyst (CFA) and president of Advisor Partners, a Walnut Creek, Calif.-based firm focused on helping advisors with investment decisions, says divestment is “a big topic and a controversial point of view,” and he notes that he schooled himself on the subject when a socially responsible client asked him about it.

Along with two of his fellow CFAs at Advisor Partners, Jim Blachman and Gerard Cronin, Kern penned a report, “Fossil Fuel Divestment: Risks and Opportunities,” which suggests that removing energy stocks from a well-diversified portfolio has little impact on investment risk. The report concludes that divestment advocates can point not only to the environmental damage caused by fossil fuels, but to the “small differences in predicted tracking error and simulated performance as evidence that divestment may be less significant [o a portfolio] than presumed.”

‘Divest Responsibly’

Divestment opponents, on the other hand, can point to the potential risk of falling behind during periods of rising oil prices. “I wouldn’t divest in my own portfolios, but I realize the value of values-based investing, especially for millennials,” Kern says. “What I tell advisors is: ‘If you’re going to divest, divest responsibly.’”

As for fiduciaries and fossil fuel divestment, San Francisco-based investment advisory HIP Investor also cites 350.org’s Fossil-Free campaign, and has published an extensive report, “Resilient Portfolios and Fossil-Free Pensions,” which states that climate change and the fossil fuel industry’s current business plan pose a pressing risk to city and state pension funds if those funds ignore emerging trends and “potentially severe losses” to their portfolios.

“The manager is instructed to evaluate all investment options according to objective economic criteria established by the manager and, if there are equally attractive investments, social factors may be considered,” the HIP report says, quoting from fiduciary education firm fi360’s prudent practices. HIP also urges trustees, fiduciaries and leaders of city and state pensions to reduce risk “by eliminating exposure to high-risk choices such as fossil-fuel energy production” and investing in more sustainable, resilient options.

Linda Leitz, newly elected chairwoman of the National Association of Personal Financial Advisors (NAPFA), says that when clients at her fee-only financial planning firm It’s Not Just Money in Colorado Springs, Colo., ask to divest their portfolio of a company for political reasons, she reminds them that it may have a bigger effect on their portfolios than they intended.

“It’s not like a cheeseburger where you can say ‘hold the pickle,’” Leitz says. “If it’s in a mutual fund or pooled asset, you can’t always control what’s in that fund. Your choice is to agree with the general principles of how the mutual fund company manages that money or to choose an alternative that you like better.”

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